BofA’s $530.45 million cash-settled notes on Merck puzzle sellsiders due to size, payoff

By Emma Trincal

New York, May 25 – BofA Finance LLC raised $530.45 million from the sale of 0.6% cash-settled equity-linked notes due May 25, 2027 linked to the common stock of Merck & Co., Inc., according to a 424B2 filing with the Securities and Exchange Commission.

BofA Finance priced $515 million principal amount of notes at 103 for total proceeds of $530.45 million.

The payout at maturity will be the greater of par of $1,000 and the alternative settlement amount. The alternative settlement amount is the product of $1,000 times the quotient of the final stock price divided by the 114% threshold price. In other words, investors will not receive any positive return at maturity unless the stock appreciates by more than 14%.

Back to the old days

This deal is the 12th largest one to have ever priced in the United States since 2004, according to data compiled by Prospect News. The data compile notes registered with the SEC at the exclusion of ETNs and plain-vanilla, lightly structured rate-linked note offerings.

One has to go back to the early days of the industry to find much larger deals such as UBS AG’s $2 billion of 22% mandatory exchangeable notes tied to Time Warner Inc. in February 2006, Citigroup Funding Inc.’s $989.48 million of 5.6% mandatory exchange notes on Genworth Financial Inc. in September 2005 or the Goldman Sachs Group, Inc.’s $563.79 million linked to the S&P Small Cap 600M Total Return index in April 2008. In 2016, Goldman Sachs brought to market another huge deal for $1.07 billion, which referenced a basket of international equity indexes.

More recently, a number of banks issued cash-settled equity-linked notes offerings tied to Voya Financial, Inc. in large block trades. Most priced in 2018. JPMorgan Chase Financial Co. LLC issued the largest one then for $600 million.

Buyers

While big offerings have always existed, few have been spotted of late.

“I haven’t seen something like that in a while,” a sellsider said about last week’s deal.

“I wonder if it was for one big client first and maybe they opened it to others.”

A structurer assumed the buyer was an institution.

“It doesn’t look like a retail deal. I don’t think retail would do such a big size. Merck is not Apple or Tesla. It’s an institutional trade,” this structurer said.

“It’s some institutional investor wanting to take a long position on Merck but with downside protection.”

Sold at a premium

The pricing at a 103 premium was also unusual for a structured product.

“You don’t see issuers selling structured notes at a premium very often. All ETF structures are done that way but with notes, that’s the exception,” said the market participant.

“It’s either part of the commission or they used it to pay for the principal protection,” the structurer said.

“Without the premium, maybe they would have been forced to up the threshold, make it at 120% for instance instead of 114%,” he added.

For the sellsider, the premium was not a fee.

“It says in the filing that BofA is not receiving any selling commission. The underwriting discount is zero.

This is a fee-based deal. The P&L for the issuer is reflected in the terms,” he said.

Out-of-the-money call

The payoff was unusual, sources said.

“The challenge is to provide principal protection. It’s hard to do because it’s expensive. The high volatility makes it more costly,” said the structurer.

“So, what they did is put an out-of-the-money call with a 114% strike. You get your upside over and above that strike.

“Alternatively, they could have done the call at-the-money, but then you would have probably lost the 100% participation. For instance, they could have given you the upside above initial price but paid only 50% of it. Here they give you 100% of the gain but over and above the strike.”

Measuring the protection

The amount of principal protection was another question subject to interpretation.

“The denomination of each note is $1,000. But the investor put $530 million and they’re only getting $515 million. That’s the 103 premium,” said the structurer.

“It’s another way to finance the principal protection. You’re not really getting the protection on 100, but on 97.

“It’s OK. The protection is embedded. They had to pay for it. They did it partly with the strike and partly with the premium.”

The market participant agreed that the threshold limited the protection of principal.

“They’re starting you off 3% behind. It’s not truly a full principal protection because the market has to go up a lot more than 114% threshold to get that 103 back. If the threshold is at 114%, you need the price to go up to 117% to get the total protection.”

Bearing interest

But the sellsider held a different view bringing up the fact that investors receive a fixed income.

“Your downside is zero. At a minimum you get 0.6% for five years and here you go: that’s your 3%. You recoup your entire premium,” he said.

“Why did they do it that way as opposed to pricing it at par, I’m not sure. It forces you to pay taxes on the income. But it effectively cancels out the premium.

“In exchange for the protection, you start participating in gains that exceed 14%. To reach a 14% threshold after five years is certainly doable.”

It is doable but not necessarily lucrative.

Modest returns

“It’s a very conservative play on the stock. If the stock is up 20%, you’re getting approximately 5%, he said.

He used the price levels as disclosed in the prospectus to illustrate his point.

On the trade date, the initial stock price was $92.07415, setting the 114% threshold price at $104.965.

A 20% increase from the initial price would push the stock price to $110.488. But investors would only receive 5.26% because the payoff of the notes is calculated from the threshold price of $104.965, not from the initial level.

“I’m really surprised they were able to get half a billion dollars when you’re only getting paid above 14%. That’s a little odd,” he said.

The notes are guaranteed by Bank of America Corp.

BofA Securities, Inc. is the underwriter.

The notes settled on Wednesday.

The Cusip number is 09709UV70.

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